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Comment by bryanrasmussen | Hacker News Reader

>What a lot of people probably dont realise when they read the term "business" is how big a fraction of management attention, incentives and remuneration is pure financial engineering

an anecdote I've shared before, was talking to an acquaintance from my child's kindergarten who was an investment guy and I said I thought that finance services were increasingly capturing too much value and he countered that was because finance was where "all the innovation is."

He later got indicted for fraud and couldn't explain how a lot of money disappeared.

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As a finance guy I don't see a lot of core innovation. Somehow I've been able to understand pretty much every financial instrument I've come across using a few basics that you learn immediately when you get into the business:

Time value of money, optionality, non-arbitrage.

There's a million ways to cook up a financial product from those and I'm not going to pretend I know them all, but it's like how a chef can look at a dish from another culture and still more or less describe what it is: sugar, fat, acidity, heat, etc.

When exciting things have happened in finance it's often been purely because the exciting thing became legal. Things like buybacks or the repeal of Glass-Steagal. The other thing that can happen is that some sales team finds a way to sell the thing that creates an ecosystem around it, like Credit Default Swaps. Rarely is it the financial contract itself that is so inventive as to create a market.

> Time value of money, optionality, non-arbitrage.

Another big one is "opacity". A financial product that is convoluted and needlessly complicated allows the most sophisticated financial players to consistently take advantage of the rest.

Much in finance is zero sum. Your outperformance is somebody else's underperformance. Financial products that are understood by everybody will not make you a lot of money, because they will trade approximately at their fair value. This is why so much in finance is complex instead of simple.

By analogy: PDF is terribly complicated because Adobe didn't want their PDF software to become commoditized. A bad and illogical file spec benefits Adobe at the expense of everybody else.

JavaScript frameworks?

An important aspect of innovation in financial services is improved risk management.

A mildly cynical person might start giggling uncontrollably at the idea that the financial sector is propagating good risk management technology, yet the picture is quite nuanced: Our world would be a more brutal place without insurance contracts and pension schemes. So there is a grain of truth. There are genuine if unfinished financial innovations and they are important. The trouble is that, by-and-large, recent decades have seen nothing of lasting utility coming from the financial sector. In fact the whole thing seems to be unwinding.

Take for example the suddenly hot topic of interest rate risk which is blowing up regional US banks left and right. This was supposed to be a solved risk management problem. Interest rate derivatives have been developed after the Savings and Loan crisis and investment banks have made gazillions of revenue peddling "interest risk management" tools.

Much has been said about the role of regional bank managers, the role of social media the role of watering down regulation etc. What I have not seen much discussed is the role of those risk management intermediaries. MIA?

I at some point a smart cookie will follow the money and publish a lurid account of how the "solved problem" went all pear shape.

Is there a book about this you recommend? Those basic concepts?

Hull. Options, Futures, and Other Derivatives.

Also Wilmott. Can't remember the name but it will be obvious.

It's pretty much high school math, you establish what the cash flows are and the value of the thing flows from there. When it comes to optionality you probably haven't done stochastic calculus in high school, but you can follow along anyway. Both books will explain interesting things like how to price an option on an option, that kind of thing. Non-arbitrage is what holds the the whole thing together: if the price didn't follow {rules} then you could do {steps} to make free money.

Paul Wilmott Introduces Quantitative Finance

you anecdote is very apposite and imho applies beyond just the financial realm.

financial innovation is dirt cheap. get enough aligned interests around a table and you can create new contracts, new financial markets etc out of thin air. its all fundamentally just a game around information control, an intermediary forcefully interjected in the economy and extracting rents.

now, the quiz: in which other sector is most "innovation" dirt cheap and essentially just a game around information control, an intermediary forcefully interjected in the economy and extracting rents?

the only thing that could be worse than what we have today is when those two "innovative" sectors merge. yet this outcome is inevitable and it will happen fairly soon.

What's the other sector? Tech?

Not the poster you are replying to, but IMO it clearly applies to a large number of tech sectors, medical care, real property, and higher education.

Pharmaceuticals?

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